Negative Gearing

Overview

The Real Estate Institute of Queensland (REIQ) is urging the federal government to reject any proposals to reform negative gearing arrangements in the Australian property market.  Allowing individuals to offset net losses from property investment against ordinary income helps to incentivise investment in property.  This assists in helping to make rent as affordable as possible for low-income members of the community and helps to ease pressure on public housing.

The objective of trying to make buying a house more affordable is an admirable one and something that the REIQ shares, however, attempts to achieve this goal via the removal of negative gearing are misguided.  Changes to existing negative gearing arrangements would not solve Australia’s housing affordability issue and would adversely impact low and middle income earners.  It would be unwise for the federal government to pursue any attempts to abolish what is merely a straightforward tax deduction for property investors.

Background

The concept of negative gearing in the Australian property market has proven to be a topic of hot discussion in recent years.  A property is negatively geared when the costs of owning it – bank charges, interest on the loan, any necessary maintenance and/or repairs, and depreciation – exceed the income it produces for the investor.  When these costs exceed the net income derived from the property investment, then the net loss may be offset against an individual’s ordinary wage income.

There has been one previous attempt to reform negative gearing, when the Hawke Government abolished it between 1985 and 1987.  As a result, the price of rent surged by roughly 24 per cent, at which point the government back flipped and reinstated it in full.  Over the last 30 years, negative gearing has remained untouched, however, in recent years it has been catapulted back onto the political agenda.

Ahead of the 2016 federal election, the Australian Labor Party (ALP) leader Bill Shorten announced a policy to reform negative gearing¹.  The ALP policy was to restrict negative gearing to only new houses beyond July 1 2017, while ‘grandfathering’ investment properties negatively geared prior to that point. Although the ALP was unsuccessful at the 2016 federal election, it remains Party policy and will therefore persist as a front and centre political issue over the coming years.

Does negative gearing favour the rich?

It is frequently argued by opponents of negative gearing that it is a concept that merely enables rich investors to minimise their tax.  Contrary to popular belief, however, the vast majority of people who engage in negative gearing on property investments are not at the wealthy end of the income spectrum. In April 2017 the Australian Tax Office (ATO) released data revealing that close to two-thirds of those who negatively gear property have taxable incomes below $80,000 per year².  In addition, the ATO data demonstrated the following facts regarding negative gearing:

• A total of 2,047,000 Australians own an investment property;
• In total 1,277,000 Australians negatively geared an investment property;
• The average negative gearing deduction is $8,702;
• A total of 807,521 Australians with a taxable income of less than $80,000 a year negatively gear; and
• More than 103,000 Australians under the age of 30 engage in negative gearing.

In addition, a report released by the Institute of Public Affairs in February 2016³ found that 80% of Australians who negatively gear have incomes under $150,000, which is outside the top marginal tax bracket.  The IPA analysis also found that the median income of Australians who utilise negative gearing to be only $88,751.  It is therefore quite clear that negative gearing largely benefits low and middle income earners and is not something that simply allows rich people to pay less tax.

Benefits of negative gearing

Despite the high degree of scrutiny levelled at negative gearing, it in fact provides a range of economic benefits that would be jeopardised if it were to be dismantled.  The sections below detail how negative gearing encourages investment in the property market; helps to lower the cost of rent; and takes pressure of public housing.

Investment in the property market

If negative gearing were to be abolished – or even significantly curtailed – it would be disastrous for investment in the property sector.  It would drive investors away from real estate and into the arms of other assets such as shares, where the offset remains in place.

A 2016 report produced by BIS Shrapnel entitled Economic Impact of Limiting the Tax Deductibility of Negatively Geared Residential Investment Properties⁴ made damning conclusions on the effect the removal of negative gearing would have on property investment.  The report predicted that the abolition of negative gearing would create a ‘discouraged investor effect’ that would reduce investor demand for housing in Australia.  The report estimated that there would be an overall reduction of new home buildings of 4%, equating to 7,200 dwellings a year.  Current owners of rental properties would also be impacted as the value of their asset declines, meaning they would also be less inclined to sell their property to a home buyer in the short-term.

In addition, a state-wide survey conducted by the REIQ in 2016 of its 14,000 Queensland members and landlord clients showed that investment in the Queensland property market would plummet if changes were made to negative gearing.  The survey was conducted following the release of the Federal Labor Party policy⁵ to limit negative gearing to only new homes, with existing negative gearing arrangements prior to July 1 2017 being grandfathered in.  A staggering 79% of respondents said they would abandon property as an investment strategy if the policy was ever implemented.  Given that the Labor policy was only a modest reform to negative gearing, the survey result demonstrates the crippling effect that any change to negative gearing arrangements would have on investor confidence in the property market.

It is clear that negative gearing is crucial in making property an attractive investment option for ordinary Australians.  The removal of negative gearing would only serve to drive investors away from the property market and the adverse effects of this are something that policy makers must be extremely wary of prior to any consideration of negative gearing reform.

Reduces the cost of rent

As negative gearing works to increase investment in property, it is therefore instrumental in keeping a lid on the cost of rent.  If negative gearing were to be either removed or wound back, not only would it result in fewer investors but it would see the price of renting a property increase due to the rental market tightening.

One of the arguments put forward by proponents of negative gearing reform is that it would put downward pressure on house prices.  Indeed, a Grattan Institute report from 2016, concluded that it would lower house prices by two per cent7.  Although this might sound like good news to aspiring home buyers, a lowering of house prices would result in investors moving to other assets and higher prices in the rental market.  The BIS Shrapnel Report also stated that reform of negative gearing ‘would result in a short run correction in real prices due to lower investor demand. However, it will result in higher rents than would be expected with negative gearing’.

Opinion is also divided among experts as to whether abolishing negative gearing would indeed increase housing supply.  Senior Lecturer in Economics at the University of Technology Sydney, Stephen Kirchner, argues that the removal negative gearing would not result in more affordable housing and would in fact exacerbate the supply problem:

Australia’s under-supplied housing market and housing affordability problem is largely due to the tax burden on housing. Abolishing the principal residence exemption from capital gains tax and negative gearing would only add to this tax burden and further reduce housing supply⁷.

The abolition of negative gearing would cause upward pressure on rental prices in the property market, something that would hit low-income earners the hardest.  Even if the removal of negative gearing assists to lower house prices, it would almost certainly be a modest reduction and should an increase in demand for home ownership occur, that would quickly see the price of buying a house increase again.

Supply of QLD public housing

The Queensland Government has previously made commitments, such as the Housing 2020 report, to transition residents from public to private housing.  Successive state governments have recognised the ability of the private sector to more efficiently service the housing market.  The removal of something that incentivises people to invest in property would therefore place further strain on public housing and is contrary to the objective of the state government to get more Queenslanders into private housing.

More than a third of all Queenslanders currently live in rental accommodation, hence, it is vital that supply is maintained to service this large portion of the Queensland community.  The abolition of negative gearing would result in fewer people being able to rent as there would be a reduction in the supply of rental properties, while other renters would also be forced out of the market as they would be unable to afford the increase in rent.  This would culminate in the state government having to divert further resources into public housing that could otherwise be spent on schools, hospitals and infrastructure.

Summary

The abolition of negative gearing would have a detrimental impact on the property market and would hit low and middle income earners the hardest.  In driving investors away from the property market, it would see low-income renters paying more for accommodation and would place further strain on their already tight household budget.  Negative gearing also assists in reducing the need for public housing, in turn meaning the state government can invest its already limited resources into other areas of responsibility such as education and health.

Those who offset the net loss of owning an investment property against ordinary income are not confined to those in the wealthiest echelon of society trying to avoid paying tax. The vast majority of those who utilise negative gearing are well outside the top marginal tax bracket and the deductions they claim are modest in size. The abolition of negative gearing would dismantle a raft of economic benefits, would fail to address the issue of housing affordability and would hurt ordinary Australians the most.

^{1) http://www.alp.org.au/negativegearing}

^{2)https://www.propertycouncil.com.au/Web/Content/Media_Release/National/2017/New_ATO_data__Almost_two_in_three_negative_gearers_have_taxable_incomes_less_than__80_000_a_year.aspx}

^{3) https://ipa.org.au/wp-content/uploads/2017/10/What_politicians_need_to_know_about_negative_gearing.pdf}

^{4) http://www.smh.com.au/cqstatic/gnanns/BISShrapnelNegativeGearingReportMarch2016.pdf}

^{5) http://www.alp.org.au/negativegearing}

^{6) https://grattan.edu.au/wp-content/uploads/2016/04/872-Hot-Property.pdf}

^{7) https://theconversation.com/how-taxing-housing-diminishes-affordability-6486}